Best in Class -- Part II

THIS YEAR'S SURVEY IS NOTABLE, TOO, for the absence of Thomas Barry, who clocked in among the top 10 managers in each of the past four years, capturing the No. 1 spot in 2002 and '04. His Bjurman, Barry Micro-Cap Growth fund is down 4% for the past 12 months, and 11% year-to-date. "Investors lost confidence in the highest-risk securities," says Barry, who invests 80% of his fund's $500 million-plus in assets in companies with market values below $500 million.

Ken Heebner of CGM Focus, No. 3.

Top honors in the small-company category now belong to Robert Gardiner of No. 7-ranked Wasatch Micro Cap fund.

MANAGERS INTERVIEWED BYBarron's in recent weeks are mixed in their assessment of the market's direction. Neil Hennessy of Hennessy Cornerstone Growth (No. 6) and Hennessy Cornerstone Value (No. 39) sees the Dow at 12,000 at the end of the year. But Daftary of Quaker Strategic Growth has 45% of his fund's $1 billion of assets in cash. "The risk level in the market is high," he says, lamenting the lack of "good ideas" among traditional growth companies.

Still, it pays to listen to this manager, who has ranked among the top 25 on our list for seven consecutive years. This year Quaker Strategic is the only large-cap domestic fund in the top 20, though much like Fairholme, it's an amoeba, sliding around the capitalization style box in search of ideas. "We go where the earnings are," Daftary says.

The fund manager also sells stocks short, a strategy he employed successfully earlier this year with Internet giant
Amazon.com
(AMZN), whose shares are down 45% in 2006. On the long side, holdings such as
Goldman Sachs
(ticker: GS); mid-cap electric utility
Allegheny Energy
(AYE) and small-cap
American Ecology
(ECOL), an environmental concern, likewise produced gains for the fund.

Daftary has a thing for consistency. He's beaten the S&P for eight straight years, trailing only Bill Miller's 15-year streak. Quaker, up 1.44% for the year through Aug. 8, trails the S&P by almost a percentage point. But Daftary is looking for a big fourth quarter to keep his streak alive.

FOR ALL HIS ACHIEVEMENTS, DAFTARY has never been No. 1 in the Value Line rankings. Connor has, finishing at the top in 2003. But the manager fell off the list in subsequent years after Barron's raised the asset limit to $100 million. With the Russian market going great guns, however, money flowed into Connor's Third Millennium offering, boosting assets past the $100 million mark last December. "When you're up 52% for the year [2005], it does wonders for your asset base," he says, adding, "It's the same ol' story. The macro environment is extremely strong. Russian GDP is growing at 6% a year. It'll be a trillion-dollar economy very soon."

Daniel LeVan, No. 4, of Boston Company International Small Cap.

There are bigger Russian-focused funds, such as ING Russia. But Connor, who served as deputy director of the Bureau of East-West Trade for the Nixon administration in the 'Seventies, literally wrote the book on investing in Russia: How to Get Rich in Russia.

That's a bit easier now that listings on the Russian market, he says, have grown to more than 60 "investible" stocks from 35 three years ago. Also, corporate governance is improving. Not surprisingly, energy plays such as Lukoil dominate the Russian market, and oil and gas eat up 50% of Third Millennium assets. But Connor has moved into other areas, recently buying Moscow-based Open Investments, a builder of million-dollar homes. What Americans don't realize, says the Nantucket resident, is that Russia "is a consumer-driven economy and there's a boom in disposable income."

Though Connor's re-emergence knocked Fairholme's irreverent Berkowitz and his co-managers from the top perch, they aren't complaining. The $3 billion Fairholme fund is up 15% through early August, easily beating the broader market. Oil and gas shares account for several of the fund's 17 stocks, but its biggest holding remains Warren Buffett's
Berkshire Hathaway
(BRKA), which recently reported strong second-quarter profits, pushing the stock up 12% in the past 12 months, to around $93,000.

Like Buffett, the Fairholme team follows the teachings of value-investing icon Benjamin Graham. The managers pick companies loaded with cash and selling at significant discounts to their estimates of intrinsic value. "We remain agnostic about the market," says Berkowitz, whose firm is based in Short Hills, N.J. "We light a candle and hope it goes down. Only during periods of stress can you find good companies at reasonable prices."

Our No. 3-ranked manager, Heebner, one of the most experienced captains in Fund-dom, also is a fan of energy stocks -- a huge fan, at that. He has parked a whopping 88% of his CGM Focus, with $2 billion of assets, in energy and mining stocks, scoring winners with oil-services giant
Tenaris
(TS), up 70% in the past 12 months, and
Phelps Dodge
(PD). Heebner says demand from countries such as China will only intensify as they build their infrastructure. Despite the run-up in energy, Heebner notes that some globally integrated oil and gas companies are selling for just seven times his earnings estimates for 2007.

CGM has returned 21% for the five-year period covered in the Value Line survey, the fourth-best performance among managers with five-year records. Heebner, who moved up from No. 7 in last year's rankings, is neutral on the U.S. market, expecting an economic slowdown. But he sees "good global" growth next year.

NO. 4-RANKED BOSTON COMPANY INTERNATIONAL, with $744 million in assets, is closed to new investors, but manager LeVan's strong showing in this year's survey should draw fans to the fund. "We are 100% bottoms-up stockpickers," he says, noting the fund works with both the value and growth sides of the Street. Along with co-manager John W. Evers, LeVan sometimes pays up for companies showing accelerating earnings growth, though the average holding in the 208-stock portfolio sports what he calls an "attractive" price-earnings ratio of 13.2 times expected earnings.

The six-year-old fund, which gained 37% in the past three years, has 32% of its assets in industrial-materials stocks. Canada's Inmet Mining and Japan's Mitsubishi Gas Chemical are core holdings. Japan is a favorite country, given the strength of its corporate earnings. LeVan also sees spending by major oil producers lifting oil-services players.

The Plainfield, N.J., native has an electrical-engineering degree from Clarkson University in Potsdam, N.Y., and served as a captain in the U.S. Air Force before joining Boston Co. in 1994. LeVan has guided the fund to its current ranking, up from No. 10 in '05, by investing mainly in small and medium-sized companies. But he says he's a bit cautious on small-caps, which now are commanding a premium to larger companies.

Callan and Michael Carey of New York-based BlackRock International slipped one notch this year to No. 5. Last year Callan told Barron's, "There are good opportunities in every sector across the world." This year he and Carey are in a similarly sunny mood, with the May correction in international equities -- which Callan calls "long overdue" -- strengthening their resolve to continue fishing in what they consider the sweet spot of international waters: small and medium-sized companies.

The managers note that international small-caps are trading at 15 times '07 analysts' earnings estimates, in line with S&P's P/E. They've funneled 45% of their assets into Asia, specifically betting companies such as Joint, a real-estate developer, will benefit from rising property prices in Japan. Carey notes the stock, up more than 50% in the year, is trading at only 10 times next year's estimated earnings, while he expects earnings to grow 25% a year.

BlackRock International, also closed to new investors, gained 42% for the year, ended June 30. One of the managers' favorite stocks, Hong Kong's Regal Hotels, hasn't fared well, but India's Bharti Airtel (formerly Bharti Televentures) has gained 30% over the past year. A modest overweight in industrial, materials and energy also has sparked gains.

Overall, the managers are expecting international small- and mid-caps to return 15% to 20% by the end of the year, compared with just 5% to 10% expected for smaller U.S. stocks.

Investors jump into relatively volatile international funds such as BlackRock to add punch to diversified portfolios. But all the funds in the Barron's/Value Line survey merit consideration for their managers' ability to make money in good times and bad. As Neil Hennessy says, "This is a stockpicker's market."

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